The City of Brotherly Love

Last June, I wrote about a new tax here in the City of Seattle – covering sweetened beverages. I was opposed to the imposition of the tax then – and remain so today.

Yesterday, came news of a decision by the Pennsylvania Supreme Court with respect to the City of Philadelphia’s imposition of a similar tax in June of 2016. Like Seattle’s tax, the Philadelphia tax is imposed at distribution and is measured on the basis of the volume of beverage sold at retail. Unlike Seattle’s tax, the Philadelphia tax is apparently levied not just on beverages that contain sugar, but also beverages that contain sugar substitutes.

Shortly after the Philadelphia tax was enacted, a group of consumers, retailers, distributors, producers and trade associations filed a lawsuit challenging the legality of the tax. In relevant part, their suit was based on an argument quite specific to Pennsylvania, and which has its roots in legislation passed in the Keystone State during the Great Depression.

The year was 1932, and Philadelphia (like most cities in Pennsylvania and the rest of the US) was in pretty bad shape. So that they might find ways to raise tax revenue and deploy it locally, the Pennsylvania General Assembly passed the Sterling Act, which gave local municipalities the power to levy, assess and collect taxes on any subject that the Commonwealth itself had the power to tax but didn’t actually tax. If a local authority levied a tax and the Commonwealth subsequently decided to impose an identical tax, then the local tax would be eliminated automatically. In other words, the General Assembly tried to allow cities to raise their own taxes without creating a risk that any particular tax would be levied twice.

In the case against the Philadelphia beverage tax, the plaintiffs argued that the Sterling Act’s prohibition on double-taxation meant that the city tax was invalid. Pennsylvania, you see, already imposed a state sales tax which covered the retail sale of beverages. After all, the Philadelphia tax was imposed at the distributor level but ultimately passed through to the consumer in the form of increased prices. As a result, from an economic point of view, the Plaintiffs argued that the Philadelphia tax was indeed a tax on top of a tax – and should be invalid under the Sterling Act.

If you like this argument, are currently in a good mood and want to stay that way, you should stop reading now.

The Plaintiffs lost at the trial court level, and then again on appeal. And yesterday, they lost at the Supreme Court. Despite the fact that both the Philadelphia tax and the Pennsylvania sales tax are ultimately borne by the consumer (an outcome that Philadelphia was aware of as they sought to use the tax – in part – to increase the price to consumers of sugary beverages and thereby decrease their consumption), and despite the fact that the Philadelphia tax was only applicable if the beverages were intended for retail sale, the Court determined that the taxes were not duplicative.

Instead, the Court sided with the defendants’ (actually the Appellees at this stage of the proceeding) position that question of tax duplication turns on “legal – and not economic – incidence.” Put another way, the Court essentially said that so long as the tax is distinct from a purely technical legal standpoint, it doesn’t matter that its burden is ultimately borne by the same party.

This is interesting for lots of reasons. But for me, two specific reasons stand out.

First, it smacks of sophistry.

But second (and maybe more importantly), this argument runs counter to the requirements that a taxpayer is generally obligated to meet when defending its tax treatment of a particular transaction. It has long been the position of the IRS (and most state taxing authorities) that the economic substance of a transaction is the critical issue in determining the appropriate tax treatment – not necessarily the form of the transaction. And yet, in this case, the taxing authority (but not the taxpayer) was allowed to proceed with the imposition of a tax on the basis of form over substance.

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Published by Brian B. DeFoe

A business lawyer with an emphasis on assisting clients in consumer-facing industries, especially hospitality and retail. I have a keen appreciation for spirits, especially single-malt scotch whiskies (the peatier the better, please) and robust bourbons.
I live on Bainbridge Island, Washington with my wife, three sons and an ever changing menagerie. My practice is based out of Seattle.
View all posts by Brian B. DeFoe